Whitney Tilson Long SODA

Why Im Long SodaStream

Whitney Tilson

October 21, 2014

Kase Capital Management

Is a Registered Investment Advisor

Carnegie Hall Tower

152 West 57th Street, 46th Floor

New York, NY 10019

(212) 277-5606

[email protected]

Disclaimer

THIS PRESENTATION IS FOR INFORMATIONAL AND EDUCATIONAL PURPOSES ONLY AND SHALL NOT BE CONSTRUED TO CONSTITUTE INVESTMENT ADVICE. NOTHING CONTAINED HEREIN SHALL CONSTITUTE A SOLICITATION, RECOMMENDATION OR ENDORSEMENT TO BUY OR SELL ANY SECURITY OR OTHER FINANCIAL INSTRUMENT.

INVESTMENT FUNDS MANAGED BY WHITNEY TILSON OWN THE STOCK OF SODASTREAM. HE HAS NO OBLIGATION TO UPDATE THE INFORMATION CONTAINED HEREIN AND MAY MAKE INVESTMENT DECISIONS THAT ARE INCONSISTENT WITH THE VIEWS EXPRESSED IN THIS PRESENTATION.

WE MAKE NO REPRESENTATION OR WARRANTIES AS TO THE ACCURACY, COMPLETENESS OR TIMELINESS OF THE INFORMATION, TEXT, GRAPHICS OR OTHER ITEMS CONTAINED IN THIS PRESENTATION. WE EXPRESSLY DISCLAIM ALL LIABILITY FOR ERRORS OR OMISSIONS IN, OR THE MISUSE OR MISINTERPRETATION OF, ANY INFORMATION CONTAINED IN THIS PRESENTATION.

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS AND FUTURE RETURNS ARE NOT GUARANTEED.

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SodaStreams Stock Has Been a Disaster I Was Early, But My Pain Can Be Your Gain

Source: BigCharts.com.

I thought it was cheap at $40 and I think its really cheap around $20!

I bought more last week

-5-

The Stock Has Collapsed Because Earnings

Have Declined (Though Theyre Still Positive)

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

$20

SodaStream recently preannounced a big Q3 earnings miss:

Revenues of $125 million vs. consensus of $153.6 million

Operating income of $8.5 million vs. consensus of $16.6 million

Quarterly Operating Income

Overview of SodaStream

SodaStream manufactures home beverage carbonation systems, which enable consumers to easily transform ordinary tap water instantly into

carbonated soft drinks and sparkling water

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SodaStream Reminds Me of Netflix

and Deckers at their Lows

1) A beaten-down stock with a high short interest (~32%)

2) A product that short sellers think is a fad but isnt

3) Fixable problems

4) An enormous, global market

5) A position of market leadership

6) A moat around the business

7) Attractive economic characteristics: strong long-term growth potential, high

margins, and a strong balance sheet

8) A low valuation

Netflix and Deckers Over the Past Two Years

-8-

Its Not a Fad SodaStream Offers a

Compelling Advantages to Customers

Numerous surveys (including my own) show that customers love their

SodaStreams for many reasons:

Cost effective

Saves up to 70% for sparkling water (only $0.23-0.27/liter) and up to 30% for carbonated soft drinks

Convenience

No lugging of heavy cans/bottles from the supermarket

Choice/variety

Keep dozens of flavors at home with minimal shelf space

Health and wellness

SodaStream cola has cane sugar not high-fructose corn syrup and two-thirds less sugar and calories than Coke

Diet flavors use Splenda not aspartame

Environmentally friendly

Re-fillable bottles means millions of fewer plastic bottles in landfills

One SodaStream bottle replaces over 10,000 conventional ones

-9-

Who Should Own a SodaStream?

A SodaStream makes sense for:

Consumers who like sparkling water at home

A sparkling-water-drinking household where some members want to add flavors

SodaStream is not primarily a competitor to traditional sodas like Coke, Diet Coke and Pepsi (SodaStreams flavors in these categories taste terrible in my opinion)

Rather, the best and widest variety of flavors are fruit-based: grape, orange, lemon, cranberry, cran-raspberry, etc.

SodaStream has exclusive rights to important brands that consumers know in these categories, such as Ocean Spray, Kool Aid, Welch's, Crystal Light and

Del Monte

-10-

Its Not a Fad Customers Love Their SodaStreams Rather, the Company Has Executed Poorly in the U.S.

SodaStream has a long-standing well-entrenched business in Europe

But what about the U.S.?

I did a survey of SodaStream users in the U.S. and my analysis of the 393 responses led me to conclude that people love their SodaStreams:

Frequent use: 55% are hardcore users they use it daily or every other day and another 18% use it at least weekly

Steady use over time: 67% of respondents who had a machine said they use it the same or more versus one year ago

High likelihood to recommend: 81% would recommend it to a friend (56% very likely and 25% somewhat likely)

Among non-owners, 9% will definitely or probably get one and 22% maybe will get one

Conclusion: SodaStreams woes in the U.S. arent due to it being a fad, but rather poor execution, especially in the areas of distribution, inventory

management and marketing

These are difficult but fixable problems though its hard to know how long it will take (its already taken longer than I expected)

-11-

SodaStream Is a Tiny Part of an Enormous

Global Market

Source: Euromomitor (2012) for beverage consumption, in SODA investor presentation, 5/13/13.

-12-

SodaStream Dominates Its Market and

Has a Wide Moat

SodaStream dominates its market

It was founded in 1903 and introduced the worlds first home soda maker in 1955

SodaStream has a wide moat, rooted in:

Its global CO2 distribution network and retail base (45 countries, more than 60,000 retail and CO2 refill outlets)

Expertise in HAZMAT (handing CO2 canisters) and reverse logistics

Brand name

An installed base of more than seven million units

World-class partners

Global manufacturing footprint

Know-how from its 50+ year history of making carbonation machines

Competitors are either vaporware (Keurig Cold) or barely detectible (Bevyz)

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SodaStream Has a Strong Brand Name

Source: SODA investor presentation, 5/13.

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SodaStream Has World-Class Partners Like

Samsung and KitchenAid


The deal with Samsung, in which it allowed their refrigerator to say "Powered by SodaStream, is particularly noteworthy, as the company is known for its vertical integration

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SodaStream Has Many World-Class Flavor

Partnerships

Ocean Spray

V8, Welchs

Crystal Light

Kool Aid, EBoost

SunnyD, Del Monte

Country Time

Note: SunnyD is the #1 juice brand at

Walmart.

Photo is from the International Home &

Housewares Show, 3/14

-16-

Even With the Stock Down So Much, It

Doesnt Appear to Be Super Cheap

Stock price (10/20/14 close): $20.78

Market cap: $439 million

Cash: $36 million

Debt: $39 million

Enterprise value: $442 million

TTM EPS: $1.31

2014 est. EPS: $1.47

2015 est. EPS: $1.68

P/E (trailing): 15.9x

P/E (2014 est.): 14.1x

P/E (2015 est.): 12.4x

EV/EBITDA: 9.1x trailing, 6.9x next 12 months est.

TTM revenues: $572 million

EV/S (trailing): 0.76x

-17-

SodaStream Has Attractive Economic

Characteristics

SodaStream has an attractive razor-and-blade business model

Prior to its recent woes, the company consistently had gross margins exceeding 50%, net margins in the 7-10% range, and returns on equity of

14-18%

The balance sheet is in good shape, with $36 million in cash, $39 million of debt and $347 million in equity

The losses in the U.S. are masking the profitability of two wonderful, high-margin franchises:

1) Western Europe

2) CO2 refill business

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SodaStream Has High Household

Penetration in Western Europe


-19-

SodaStream Has Very High Margins in Its

Mature Markets


(U.S. operating margins are likely negative now)

-20-

SodaStreams Western European Business Alone Is

Worth More Than the Entire Current Market Cap

In 2013, SodaStreams Western European business generated revenues of $269 million, grew 31% over the prior year, and generated $55 million in pre-tax income, a 21% margin (prior to

allocation of corporate overhead)

The rest of the world, in contrast, had revenues of $294 million, representing 27% growth over the prior year, and generated $27 million in pre-tax income, a 9.1% margin

Thus, Western Europe accounted for 48% of SodaStreams sales, yet generated 67% of the companys pre-tax profits (before overhead)

Note that Western Europe actually grew faster than the rest of the world, which is strong evidence of the quality of SodaStreams Western European franchise as well as the fact that the region is mix of mature markets and those that are still fairly early in the growth curve

If we allocate corporate overhead proportional to revenues, then Western Europes pre-tax profit after overhead was $39 million

With a 10% tax rate (what SodaStream paid in 2013), thats $35 million in net income or $1.65 in earnings per share

What is the value of a well-established franchise with a 21% pre-tax margin and 10-15% top-line growth (growth was 17% in Q1 and 14% in Q2)? I think its hard to say thats worth less than 15x after-tax earnings, which would make Western Europe worth ~$25/share

A 12x-18x range results in $20 - $30

In short, I think SodaStreams Western European business a fabulous high-margin, strong growth franchise is, by itself, worth more than SodaStreams entire market cap today, which means that investors are paying nothing for the U.S. business plus further growth in Japan,

Mexico, China, India, Brazil and elsewhere

Primary concern: SodaStreams Q3 earnings warning only mentioned problems in the U.S., but it was a big enough miss that investors are concerned that SodaStream is now struggling in

Europe as well. I think this is unlikely, but if so, this would be a big negative for the stock.

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SodaStreams CO2 Distribution Network Is

a Wonderful Business

SodaStream offers consumers the ability to exchange their empty 60- and 130-liter CO2 canisters for full ones at a growing list of local retailers (at

price points of approximately $15 and $30, respectively)

Today SodaStream has over 60,000 retailers participating in its CO2-exchange program a network that took over 10 years to build and would be extremely difficult to replicate

It costs SodaStream very little to refill an empty CO2 canister, so it earns extremely high refill margins (estimated to be ~85%) while providing a

compelling value proposition to consumers ($0.23-0.25 cents per liter)

Many markets do not allow CO2 refills by mail therefore would-be competitors who do not have a refill exchange network have been

relegated to using small disposable CO2 canisters that cost $1-2 per liter)

The effectiveness of this barrier to entry is evidenced by list of potential competitors like Samsung who have opted to partner with SodaStream to

provide their CO2, rather than to try to duplicate its distribution network

-22-

SodaStreams CO2 Refill Business:

Growth Is Slowing, But Still Robust

Source: SodaStream.

0

1

2

3

4

5

6

7

Q1 Q2 Q3 Q4

2009 2010 2011 2012 2013 2014

Refills

(millions)

+17% year-over-

year growth

+22%

+25%

+34%

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SodaStreams CO2 Refill Business Alone Is Also

Worth More Than the Entire Current Market Cap

The company sold 6.5 million refills last quarter, which has grown each quarter on a YOY basis for the last five years.

Given that the average user refills their CO2 about 3-4 times per year (which equates to a little more than 1 liter every other day per household), 6.5 million refills in Q2

suggests a repeat active user base of 7+ million consumers

This doesnt include the new active users generated from among the 785,000 soda makers sold in Q2

A refill purchaser (or active user) is someone who clearly likes the product and has taken the trouble to replace the canister

This user will have a much lower churn rate than the population of consumers who purchase a soda maker starter kit (or receive one as a gift) and the required

marketing spend to maintain an active user is lower than for acquiring a new one

This leads to the following math on the CO2 exchange business:

26 million exchanges per year (Q2 annualized) * $7.00 per exchange (net to SodaStream) = ~$182 million of revenue

Assuming ~85% gross margins and a 12% tax rate, thats fully-taxed gross profit of ~$136 million

With an enterprise value of $442 million, SodaStream is trading for only three times the fully-taxed gross profit stream from its growing CO2 refill business

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SodaStreams CO2 Refill Business Alone Is Worth

More Than the Entire Current Market Cap (2)

The next question is: how much spending is needed to fund the G&A of this CO2 business, and how much sales and marketing is needed to keep

the active user base stable and growing?

The thought being that at ~3x earnings, even modest growth of this user

population would represent a compelling value The existing soda maker and flavors divisions in 2013 generated

approximately $170 million of gross profit

Since the whole business had $50 million of G&A, this means that the soda maker and flavors gross profit could pay for all of the companys G&A and still leave $120 million extra to be used as sales & marketing

spend to grow your active-user-base CO2 profit stream

In 2013, the company spent $186 million on sales & marketing and this investment produced 29% total company revenue growth

So how much growth would $120 million get you? 5-15%? That would be more than enough if you looked at the active-user-CO2 profits of $136

million as a growing annuity

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In other words, while SodaStream may not look particularly cheap today on newly-lowered GAAP EPS, it looks very cheap if you ask yourself how

much you are paying for the fully-taxed earnings of the active user CO2

exchange business

This seems like a more substantive business because we already know these users like the product, and because CO2 exchange has very high

barriers to entry

So the bears could be right that this company never gets very big, and the reply is: So what? Then we are getting a bargain on a profitable, growing niche business with higher barriers to entry

Note that SodaStream has grown its total soda maker sales each year and last year sold 4.4 million new ones. If half of these purchasers

become active users, it should be more than enough to offset any churn of

the active user base. In fact, soda maker sales could decline to 2-3 million

annually and the active user population could continue to grow nicely

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As a cross-check to the value we see in the business, we said suppose SodaStream were a private business and we owned all the shares and we

decided that we would be satisfied with a lower growth rate

With 21.4 million shares outstanding, every 10% reduction in sales & marketing translates to $0.87 of operating profit per share, or about $0.70

of EPS

Suppose we believed that we could cut sales and marketing by 40% to $112 million and still grow the business by ~10% per year, our fully-taxed

EPS after subtracting share-based comp would be about $4.22 per share,

rather than the current profits of around $1.42, implying a multiple of 5x

EPS

Would you pay 5x earnings for a profitable business with barriers to entry growing 10% annually?

-27-

SodaStreams Deal With Samsung Could Lead to

Substantial Incremental Profits on CO2 Refills

Samsung did an initial, limited launched in 2013 of its Powered by SodaStream refrigerators in the US, Canada, Australia and South Korea, and is now rolling it out

in approximately a dozen of SodaStreams established markets in Europe

Sales must have been strong in the initial countries or Samsung wouldnt be expanding distribution

Later this year Samsung is launching two more models

There are approximately 50 million refrigerators sold globally each year, of which Samsung claims to have 10.3% share

I estimate that 200,000-300,000 Samsung Powered by SodaStream refrigerators will be in circulation by the end of this year (4-6% of units sold)

I dont think its a stretch to guess that the installed base by the end of 2015 could be 500,000 to 1 million, and perhaps two million by the end of 2016

The upside will depend on customer adoption of course, but also other factors such as Samsung including SodaStream in lower-end models and SodaStream negotiating deals

with other brands like market leader Whirlpool/Kitchen Aid

Every 1.25 million refrigerators in circulation translates into a very high quality (i.e., recurring) ~$1.00 of EPS for SodaStream

1.25 million * 3.5 refills per year *$7.00 per refill * 85% gross margins * 15% tax rate, divided by 22 million shares

Its possible that SodaSteam could exit 2016 with a run-rate of $1.50-2.00 of annual recurring EPS coming just from refrigerator CO2 refills

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Might Competitors to the CO2 Refill

Business Emerge?

In light of the size and profitability of SodaStreams CO2 refill business, might competitors emerge? I think not:

SodaStream has a proprietary and patented valve connecting the canister to the soda maker, making the soda maker incompatible with other canisters and

preventing the canister from being refilled

SodaStreams scale allows it to manufacture canisters at a lower cost than any other supplier can obtain them

Even if a competitor were to engineer a compatible canister that didnt violate SodaStreams patent, they would be faced with the daunting (I would argue impossible) task of persuading tens of thousands of retailers to carry the

generic alternative (and dedicate storage space, set up reverse logistics, violate

the exclusivity agreement they have with SodaStream, etc.)

The entire refill process/ecosystem is enormously complex, so any would-be competitor would be hard-pressed to match SodaStreams scale, experience and know-how

A refill only costs ~$15, or approximately $50 annually for a typical customer dollar amounts that arent likely to attract competitors or cause customers to seek alternatives

In summary, there are many strong reasons why no refill competitors have emerged, even in countries in which SodaStream has been present (and making fantastic

margins) for more than a decade

-29-

Might Customers Hack Their CO2

Canister?

Various products have been introduced by third-party vendors that allow customers to connect cheaper CO2 canisters to their soda makers

For example, one option is the SodaMod, a $60 valve that allows a standard paintball CO2 canister, which costs roughly $3, to connect to a SodaStream

I dont view hacking as a meaningful threat for a variety of reasons:

The up-front cost of the value ($60) plus canister (~$20), which costs as much as a low-end soda maker ($79 on Amazon today)

Its a long (roughly two-year) payback for the average customer, whose refill costs might drop from $50 to $10 per year

The valve requires some technical ability to install

There is only a tiny fraction of the distribution network available for paintball canisters relative to what SodaStream has built the savings dont warrant the hassle

CO2 canisters contain highly pressurized liquefied gas and if something goes wrong, the results could be burns, dangerous gasses being released, etc.

I think only a tiny fraction of customers are willing to take even the slightest risk

Its not clear if the industrial-grade CO2 used in paintball canisters is as pure as the consumer-grade CO2 SodaStream uses

In summary, this is an option only for a handful of hardcore enthusiasts

-30-

What About the Threat From Keurig Green

Mountain/Coke and/or Pepsi/Bevyz?

Keurig Cold doesnt exist and there is no firm date for its launch

Im highly skeptical that it will reach shelves this year

Im equally skeptical that the proposed chemical-based carbonation (thus eliminating the need for CO2 canisters) will live up to expectations

There is talk that the degree of carbonation will be significantly lower than with a SodaStream machine; if so, will Coke really put its brand on this?

At anticipated price points of $200-300 for the machine and $0.60-0.80+ per serving for Keurig Cold and Bevyz multiples of SodaStreams prices they are unlikely to have mass appeal

While a single-serve coffee machine like Keurig makes sense (as the alternative is to brew an entire pot of coffee), Coke, Pepsi and other

sodas are already sold and widely available in single-serve containers

The target SodaStream customer is not a hardcore Coke/Pepsi drinker

They tend to skew higher income, be more health conscious, etc.

Keurig Cold and Bevyz will not make sense (economically or otherwise) for consumers who just want seltzer (SodaStreams core customers)

Keurig Cold and Bevyz will not make sense for consumers who want larger portions than single-serve (i.e., for gatherings in which you want

bottles of seltzer on the table, or families with lots of kids)

-31-

What Could Go Wrong?

The U.S. business could continue to suck wind and the company could waste a lot of money in a futile attempt to turn it around

Any slowdown in sales of CO2 refills (of which there has been scant evidence to date) would hurt profitability and could indicate increased

churn among active users

Competitors could make inroads

Valuation multiples could compress further

-32-

Conclusion

This is primarily a non-U.S. business, but most of the shareholders are U.S. based, so I think theyre projecting the problems they see here onto the entire business

I think there are two primary ways to win:

1) Management stabilizes the U.S. business so its no longer a drag on the rest of the company

This is the core of my investment thesis

2) SodaStream is acquired or attracts a large partner, similar to the GMCR/KO

deal

There have been numerous reports of possible deals with financial buyers around $40, which wasnt interesting when the stock was in the $30s but its a different story with the stock at $21

The downside is well protected by two fabulous embedded franchises: Western Europe and the CO2 refill business

My price target is $40, equal to 20x run-rate earnings for Western Europe or 6.2x the after-tax gross profit of the refill business

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Whitney Tilson Long SODA

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